Saturday, March 27, 2010

This post graphs stock market dividend yields since 1900 and shows that they are at historically low levels. Since the price/dividend ratio is the inverse of dividend yield, valuations based upon p/d ratio are at an all-time high. Historically, expensive markets such as these have produced disappointing long-term returns.

I've argued elsewhere that valuation is important -- it is important not to overpay for investments. A common basis for valuation is earnings; investors decide how expensive the market is based upon how much one has to pay for one dollar of earnings -- the price / earnings ratio. In this blog, I refine that a bit and look at normalized price/earnings ratios. (About Normalized P/E Ratios describes my normalization process.) However, this is not the only way to assess valuation. Another popular valuation metric is the price/dividend ratio -- how much must an investor pay for one dollar of dividends (or, conversely, what is the investor's dividend yield)?

Projected 10-Year Stock Market Returns

Projected Dow 10-Year Returns

The above graph (click to expand) shows my projected returns for the DJIA (Dow Jones Industrial Average) for the twelve 10-year periods beginning end-of-year 2000 through end-of-year 2011. The blue dashed line shows the returns that I estimated that a hypothetical investor in the stock market would receive over the next ten years